The Real, Real Price of Gasoline: Probably Lower Than You Think

Gasoline prices toy with our minds in way few other products can. As behavioral economist Dan Ariely once explained:

For the several minutes that I stand at the pump, all I do is stare at the growing total on the meter -- there is nothing else to do. And I have time to remember how much it cost a year ago, two years ago, and even six years ago. Yet I have no such memory about the prices of items in any other category. I have no idea how much milk was six years ago, how much bread was three years ago, or how much yogurt was a week ago.

Everyone can relate to this.

But there are flaws that come from our obsession with gas prices.

The big one is that most Americans earn more today than they did in past years -- especially in nominal terms (not adjusted for inflation). While the price of a gallon of gas is up 170% since 1990, the average hourly wage doubled during that time, making the "real" rise in gas prices much smaller than it appears.

But there's a lot more to this story than that.

Two other powerful forces have indirectly affected how much Americans pay at the pump:

Average fuel efficiency has increased tremendously over the past two decades, particularly since 2005.

Americans are driving fewer miles per year now than they were in the past. That's in part due to a weak economy, but it's also due to demographics and urban living trends (more on that here).

Both have to be considered to get a sense of the real, real price of gasoline -- not just the sticker price we see at the pump, but the actual impact it has on our finances.

Doing so isn't terribly complicated, and it leads to this:

Source: Department of Transportation, Energy Information Agency, Bureau of Labor Statistics. The formula used to calculate this graph is: (average gas prices/average hourly wages of nonsupervisory workers) * (annual miles driven per capita/average MPG of passenger cars). This produces an index figure, which was then scaled using March 2013 gas prices as a base.

There are two big takeaways from the chart.

One is that gas prices are much higher today than they were during the 1990s and early 2000s. There's no disputing that.

The other is that real gas prices are no higher today than they were a decade ago. That's largely due to two factors. In 2003, the average new passenger vehicle got 29.5 miles per gallon, while today a new car averages 35.6 MPG. And annual miles driven per capita has declined 5% over the past decade.

To me, that highlights one of the most important forces people ignore when forecasting future demand: Consumers' ability to adapt to higher prices. And that adaptation, of course, was born out of last decade's gas spikes that ate into consumers' wallets. "The key to high prices is high prices," as the saying goes.

Daniel Yergin, an energy analyst who won a Pulitzer for his book The Prize, calls efficiency and conservation "the fifth fuel," writing that "many would not even think of it as a fuel or an energy source. Yet in terms of impact, it certainly is." He continues:

The United States uses less than half as much energy for every unit of GDP as it did in the 1970s ... a new car in the 1970s might have averaged 13.5 miles to every gallon. Today, on a fleet average basis, a new car is required to get 30.2 miles per gallon.

It will also probably serve as one of the most important solutions to global energy problems, writes John Authers of The Financial Times:

This spasm of activity [shale boom] has put to rest the fears that "peak oil" production had arrived, fashionable during the price spike five years ago. But there is a limit to how far supply can be increased, and political and economic limits to the environmental damage that can be tolerated.

Once popular bets on alternative energy technologies have now fallen out of favor. Ethanol production led to a spike in agricultural commodity prices, for example. That leads to a new theory: that the next five or 10 years will be devoted to a bid to improve energy efficiency.

It's already more than a theory. The new fleets of vehicles being produced by Ford and General Motors have a common denominator: A forceful push away from power and size toward efficiency. Whether it's an SUV or a tiny commuter car, efficiency now sells, and that's what automakers are delivering.

Oscar Wilde once wrote about those who know "the price of everything but the value of nothing." He may as well have been talking about how we think about gas prices.